The Commercial Mortgage Securities Association (CMSA) yesterday presented new data on the pricing of commercial mortgage-backed securities (CMBS) compared to their fair value and returns relative to risk profile. The study predicts CMBS will perform well in a deteriorating recessionary environment.
It concluded that current spreads for most CMBS vintages are still far wider than their fair value, an irrational market reaction that presents significant arbitrage opportunities for investors.”There are no skeletons in the CMBS closet,” said Jun Han, Ph. D., the author of the study.
The study performed multiple stress tests on CMBS bonds based on three historical and worst-case recession scenarios. It analyzed all 19,583 commercial mortgage loans in the 675 CMBS bonds that make up the four CMBX indices, which account for approximately 39% of fixed rate conduit CMBS outstanding.
The study concludes that investors have strong reasons to be optimistic. Among the findings revealed were:
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Fixed-rate, investment-grade CMBS perform very well in the study’s stress-tested analysis, with minimal defaults, credit losses or yield degradation. No CMBS rated AA or higher are expected to incur any loss under the study’s recession scenario, while 99% of A-rated CMBS should be free of losses and the remaining 1% should incur only a small loss.
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The risk of CMBS downgrades is very limited. For example, 98% of AAA-rated CMBS and 94% of A-rated CMBS are at no risk of downgrade in a recession scenario.
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Current CMBX index spreads unreasonably imply a “doomsday scenario,” with such spreads implying that future defaults and losses would be many times the levels of historical experience. Incredibly, when applying the spreads at which the CMBX 4 index has recently traded, the implied annual collateral default rate was over 100% for AAA-rated CMBS on March 20, compared to a historical CMBS average of less than 1%.
“Just how off-target is the CMBX market? We can actually put a dollar value on it,” Dr. Han comments. “When applying a worst case 1986 stress test scenario, spreads on the CMBX 4 index of almost 1,200 basis points over T-bills, were almost twice as high as would have been expected at fair value.”
“This demonstrates the kinds of distortions and limitations of ceding the determination of value of the nearly $1 trillion CMBS market to an untested and volatile derivatives index during an unprecedented credit and liquidity crisis.”
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